This paper analyzes mergers and acquisitions (M & A) as a previously neglected channel of industrial restructuring in the face of trade liberalization. Using the Canada-United States Free Trade Agreement of 1989 as a natural experiment, I show that trade liberalization leads to a significant increase in M & A activity. I also provide evidence that resources are transferred from less to more productive firms in the process and that the magnitude of the overall transfer is quantitatively important. Taken together, these results suggest that M & A is an important alternative to the previously studied adjustment channels of firm and establishment closure and contraction. This has strong implications for the design of competition policy in the wake of trade liberalizations since M & A may offer a more efficient way of transferring resources than contraction and closure of low productivity firms combined with internal growth of more efficient firms.

It is often thought that a tariff reduction, by opening-up the domestic market to foreign firms, should lessen the need for a policy aimed at discouraging domestic mergers. This implicitly assumes that the tariff in question is sufficiently high to prevent foreign firms from selling in the domestic market. However, not all tariffs are prohibitive, so that foreign firms may be present in the domestic market before it is abolished. Furthermore, even if the tariff is prohibitive, a merger of domestic firms may render it nonprohibitive, thus inviting foreign firms to penetrate the domestic market. Using a simple example, the authors show that, in the latter two cases, abolishing the tariff may in fact make the domestic merger more profitable. Hence trade liberalization will not necessarily reduce the profitability of domestic mergers.